Is a Fund Manager’s Life ‘Nasty’ and ‘Brutish’?

By Brendan Conway

Oh come on!

That was my first reaction to the Bloombergheadline this week, “The Nasty, Brutish Life of the Modern Mutual Fund Manager.” The words, after all, are from Thomas Hobbes, who made them famous in Leviathan. Hobbes theorized what human life would be like in the “state of nature” — i.e., what you face when there’s no government and no laws, only the rule of the strong:

In such condition there is no place for industry, because the fruit thereof is uncertain, and consequently, not culture of the earth, no navigation, nor the use of commodities that may be imported by sea, no commodious building, no instruments of moving and removing such things as require much force, no knowledge of the face of the earth, no account of time, no arts, no letters, no society, and which is worst of all, continual fear and danger of violent death, and the life of man, solitary, poor, nasty, brutish, and short.

So picture your well-paid investment professional with his cuff links as living a life that’s “nasty.” Then come up with an adjective for, oh, any number of billions of people around the world in low-income countries.

Okay, now that that’s out of the way, let’s put the first reaction on hold to consider this. Fund managers do face something approaching their own “state of nature,” as the story by Bloomberg’s Ben Steverman recounts. But it’s not of the Hobbesian kind — much the opposite.

A little more than a decade ago, the government removed a particularly helpful type of social chaos which used to goose fund-manager returns. The name of this action was “Reg FD.” From Steverman:

It used to be chummier and less cutthroat. When Bob Bacarella, 65, started investing in stocks 30 years ago, he could phone executives — and actually speak to them — while asking for information that could get someone thrown in jail today: “Hey, how were sales last week?’”

Now companies release news to all investors at once. Data points are instantly fed through sophisticated computer models and interpreted by squadrons of analysts. Research that used to take weeks must be shortened to hours or minutes. Managers say it’s “bewildering and overwhelming,” says Jason Voss, a former fund manager who’s now a content director at the CFA Institute.

If skilled managers of active funds have such trouble, why not just rely on cheaper index mutual funds or exchange-traded funds that track broad market segments?

The rise ofRegulation Fair Disclosure, its full name, is much the opposite of the Hobbesian state of nature. It’s the state telling you what to do — and, I’d argue, for the good. It did this by effectively outlawing legalized insider trading, including, obviously, by stock-picking fund managers.

Last year, more than half of large-cap managers missed the index. This year early signs suggest it’s back to the doldrums. As of mid-May, a paltry 8% of large-cap growth managers were estimated to be ahead of the Russell 1000.

Reg FD, I’ll argue, is the single least appreciated reason so many fund managers now trail the index so badly.

This blogger spoke with Nomura quant Joe Mezrich on the subject several months ago. Mezrich pointed to market correlation as the place where Reg FD’s rubber met the investing road. It contributed to stocks’ tendency to march in greater lockstep to a greater degree in recent years, by erasing the grey areas where fund managers thrived (the trend predates the financial crisis).

If the correlation of stock returns has lurched permanently higher, then the opportunity to stand out is, by definition, lower:

Stock correlation shows no sign of returning to the levels of the 1980s and 1990s, when stockpickers ruled. The best theory as to why is also the most disheartening: regulatory and cultural changes, which don’t shift overnight. Correlation roughly doubled in 2002 to 2003 and never returned to lower levels. Instinet quantitative strategist Joseph Mezrich points to factors such as the passage of Regulation FD (“fair disclosure”) in 2000, which reduced managers’ ability to reap an information advantage over less informed investors (through what amounted to legalized insider trading).

That was after the late 1990s and early 2000s saw the rising popularity of macroeconomic and “factor” investing. Then in 2002, following a series of accounting scandals, the Sarbanes-Oxley Act reduced the amount of opaque financial reporting. The result, Mezrich argues, was more homogeneity and, hence, more correlation in the stock market. The period coincided with the rise in popularity of exchange-traded funds—as well as active managers’ big drought.

So, a life that is nasty and brutish, by this standard. And let’s throw in the Hobbesian “short” while we’re at it.

About Focus on Funds

As exchange-traded funds and other investing vehicles have ballooned in number, the task of figuring out what works well and what doesn’t has only gotten harder. Barrons.com’s Focus on Funds looks under the hood of ETFs, mutual funds and hedge funds for overlooked values, actionable ideas and the latest pitfalls for fund investors.

Chris Dieterich has covered the U.S. stock market for The Wall Street Journal and Dow Jones Newswires. He is a graduate of Regis University and the Missouri School of Journalism.